Risk Exposure to Corruption

In a recent report, Transparency scores companies on their risk exposure to corruption using key criteria that include public disclosure of anti-corruption systems, geographical disclosure, jurisdictional exposure, past settlements and current allegations. Companies in key sectors receive a grade from A to F. The scoring system for public transparency is based on an in-house methodology created by Transparency International, which they consider to be the benchmark in its field. They add certain criteria around the area of whistle-blowing, which they maintain as playing a central role in protecting companies and therefore investors against corruption risks.

Sector Risks Emphasized Under New Regulation

Extractives on Front Line

The oil, gas and mining sectors which have been exposed to corruption risks and a number of high-profile cases perform strongly in the area of public disclosure. However, they remind investors that even with strong disclosure of anti-corruption systems, current allegations still present critical risks for investors even though they sometimes date back a number of years. This is the case with Total SA (ADR) (NYSE:TOT), Eni SpA (ADR) (NYSE:E), and Saipem SpA(ADR) (OTCMKTS:SAPMY) (BIT:SPM).

Also they focus on the extractives sector explicitly as payment transparency regulation has been enacted in the U.S. and is currently being finalized in the EC for the sector. It will require country-by-country reporting of the major payment types to governments at a national and project level. The view is that those companies with the highest quality anti-corruption systems will be best positioned for such legislation, whose major ramifications will be in the area of uncovering illicit payments.

Forestry Makes an Appearance

Forestry has been included in EC legislation proposals and they identify it as a key sector. Its disclosure is poorer than its oil-and-gas and mining extractive peers, and in the coming years they would expect logging activity to be a subject of greater focus.

Telco, Construction and Banks Now on Radar Long Term

They also present a broad overview of three other sectors which have been proposed for payments transparency: telecom, construction and banks—these sectors have been recently dropped but in the long term are more likely to be included again within future legislation. Telecom companies have had a number of allegations primarily related to the acquisition of licences in emerging markets. They reiterate concerns regarding ongoing risks to investors where companies in this sector have not implemented adequate systems against corrupt payments. Construction is a sector that performs poorly on disclosure but where allegations, though smaller in scale than extractives and telecom, continue to have an impact on investors. In a small sample of companies within the banking sector, they highligh that disclosure remains poorer as a whole and that risks surrounding illicit payments feed into a number of major recent controversies that are affecting shareholder value.

Best and Worst Practices: What Really Differentiates Companies?

Below are the questions which correlate to the best and worst scores–worst practices are more self-evident: if a company does not disclose even any theoretical anti-corruption commitment, it is unlikely to be able to implement the accompanying systems to ensure the reduction of corruption risks. One might say that failure to answer positively and clearly on these base questions represents a clear risk to shareholder value for any company with a global presence, especially in the riskier sectors. By contrast, those best practice questions to the left of the table require a level of awareness on the company's part of its own risks and also a level of implementation which can be considered advanced in order to disclose publicly that it conducts anti-corruption due diligence systematically in M&A activity.

Best practices: Examples

Facilitation Payments

Rio Tinto plc (NYSE:RIO) (LON:RIO), with a primary listing and major management office in London. would certainly be exposed to the U.K. Bribery Act. Its approach to facilitation payments states clearly, "The only way to guarantee compliance with UK laws on bribery is to avoid making facilitation payments anywhere in the world." It goes on to recommend that operations set out a long-term strategy to reducing exposure to these payments and receipt or written confirmation of its legality, inform senior officials of relevant government agencies about any unofficial requests for cash, and seek to build alliances with other firms facing similar problems."

Risk Assessment for Business Decisions

Statoil ASA(ADR) (NYSE:STO), the best performer all round for anti-corruption systems disclosure, notes a variety of processes integrated into its operational and business models that are related to the following risk areas:

Country risks as evidenced by perceived high levels of corruption and an absence of effectively-implemented anti-corruption legislation, among

About the author

K.C. Hayes is MBA in Finance with over 5 years of experience in Equity Research, including a tenure as analyst at one of the largest hedge funds in the world. His area of interest includes Financial Modeling, Valuation & Value Investing. K.C. Hayes is a pen name.